September 21, 2021
In 2019, the electric power sector was the second largest contributor to greenhouse gas emissions in the US.1 Without federal policy that mandates utilities to transition energy grids, hitting near-term emissions targets could be difficult, according to Newton portfolio manager Paul Flood.
In August 2021, the US Senate passed a US$1trillion bipartisan infrastructure package, but critical climate elements were left out. Although the package includes more than US$150bn to promote climate resilience against hurricanes, wildfires and droughts, it omits President Joe Biden’s proposed national Clean Electricity Standard (CES), a requirement to use renewable sources in the national grid.2 If the US plans to catch up with more progressive countries in Europe, this omission of strong federal incentives could be problematic, according to Flood.
“At the federal level, we don’t see many incentives to try and restrict carbon intensity,” he says. “For instance, there’s a carbon tax in the UK and I believe the US could benefit from something having something similar in place.”
While the proposed CES did not include a carbon tax,3 it would have required a segment of retail electricity sales to come from low and zero-carbon sources, including wind, solar and geothermal generators, as well as nuclear power and fossil fuel generators with carbon capture and storage. Despite the exclusion of this key piece of federal legislation, positive work is being done at the state and local government level, according to Flood.
Many US states have enacted Renewable Portfolio Standards (RPS), which incentivise utilities to transition energy grids.4 Under these mandates, utilities earn renewable energy credits (RECs) for each megawatt-hour of electricity generated from a renewable energy source.5 Credits are then used as proof they are compliant with state regulation and can be sold on the open market as an energy commodity. This provides utilities with a second stream of revenue, further incentivising them to invest in renewable technology. Businesses and individuals, who mostly purchase RECs to lower their carbon footprint, also drive demand in the renewable market, potentially encouraging more supply while helping to lower costs.6 In Flood’s view, the risk of investing in pro-climate projects such as renewables is somewhat mitigated through such state policy incentives.
“They’re not risk-free investments, so the goal is to derisk the volatility investors might incur,” Flood says. “As that happens, renewable power sources become more cost competitive with traditional power generation, which is economically supportive of the no-carbon era. However, in many cases, renewables have a lower levelized cost of energy than traditional forms of power production already.”
Some states have gone so far as to require major utilities to close all carbon-emitting power plants by a certain date. In 2020 the state of Virginia passed a law that would require its largest utility to decommission all carbon emitting plants by 2045.7 While this may be a step in the right direction, Flood says federal policy needs to catch up in order for the US to meet its emissions targets. But, he adds, the US is not the only country struggling with policy.
“In the UK, current policies only get us to 26% of the intended 78% reduction target by 2030. But the policy gap in the UK will likely close over the next five years.” Flood says. “If you think about it, policies in place today would’ve seemed extreme just three years ago. That said, all around the world, it’s accelerating at a promising pace and there’s already supportive rhetoric from the Biden administration.”
Some investors worry about the notion of stranded assets – assets that once had greater value but no longer do – in the fossil fuels and energy sector. With an accelerated phasing out of coal, oil and even gas, where does that leave utilities dependent on traditional power generation? If they have a transition plan in place, they should survive, according to Flood.
“Several companies with low environmental, social and governance (ESG) scores are making big strides to transition away from their fossil fuel dependency,” Flood says. “Eventually investors will move way from focusing on short-term factors and will utilize positive screening, which involves looking for companies that are doing the most to change their business models.”
On this point, a carbon intensity score may not tell the whole story. Fundamental analysis of what a company is doing, as well as how likely it is to stick to its plans, should be considered. Some companies trade at lower multiples than competitors which rate better with respect to independent ESG factors. But many assets in the power sector can offer stable revenue streams at a time when income generation is becoming harder to find, Flood notes.
“Assets with revenue streams less sensitive to the economic backdrop can give a level of diversification to investors. As more people retire and need income, there should be greater support for these types of assets. And as renewables reach economies of scale, we believe that will help drive opportunity in the space as well,” he concludes.
1 US Environmental Protection Agency: Total US Greenhouse Gas Emissions by Economic Sector in 2019. 2021.
2 MarketWatch: Senate infrastructure bill leaves out clean electricity standard and jobs-focused climate corps sought by Biden. August 3, 2021.
3 Forbes: Can President Biden get the clean energy standard across the goal line? August 1, 2021.
4 Bipartisan Policy Center: Pathways to decarbonization: The National Clean Energy Standard. Accessed August 2021.
5 National Conference Board of Legislatures: State Renewable Portfolio Standard and Goals. April 7, 2021.
6 Energysage: Renewable Energy Credits. December 23, 2020.
7 Greentechmedia: Virginia Mandates 100% clean power by 2045. March 6, 2020.
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